I am in debt. A lot of debts. I have more than $700,000+ in outstanding non-mortgage debts. However, I am not any poorer because of this mountain of debts. It’s actually helping me make more money instead of being a burden that weighs down on my finances and eating away my income every month. I am not stressed by debts nor am I working just to pay it off.
You see, a few years ago, I discovered that not all debts are bad. There are good debts too. These are debts that you inherited for the purpose of investing in appreciating assets like stocks and real estates. It takes a great deal of discipline and self-control to borrow to invest. If done correctly, you will have debts working for you instead of you working to service your debts.
You must be wondering, “what does using good debts have to do with getting out of debt?” Two simple words: discipline and self-control. To get out of debt, you can use the same discipline to rein in your spending. You’ll also need to have the self-control to ensure that you purchase more of what you need rather than what you want. Once you have developed the discipline and self-control, you can choose the best way to get out of debt. Let’s take a look at the different methods.
The Debt Avalanche Method
The debt avalanche method is one of the two popular ways to get out of debt that most personal finance experts will recommend. This method involves paying the minimum payments for all of your outstanding debts and use any extra money to pay off your highest interest debt. For example, if you have three credit cards with interest rates of 12%, 15%, and 20%, you’ll pay the minimum payment for the first two credit cards. You use the rest of your money to pay off the 20% credit card.
From a pure logic point of view, this method is relatively efficient as you tackle the most costly debt first. From a savings point of view, it’s not getting you out of debt any faster. There are better ways.
The Debt Snowball Method
The Debt Snowball method is the other popular way to get out of debt. This method involves paying the minimum payments for all of your outstanding debts and use any extra money to pay off your smallest debt load first and then the second smallest. For example, if you have four loans with outstanding amounts of $2,000, $3,000, $5,000 and 20,000, you’ll pay the minimum payment for the three largest loans. You use the rest of your money to pay off the smallest loan ($2,000 loan) first.
From a mathematical point of view, this method is relatively inefficient most of the time as you ignore the interest cost of the loans. From a psychological point of view, it can be a motivating factor as you are slashing down your debts. One by one. However, it’s not getting you out of debt any faster or save you more money. Once again, there are better ways.
The Debt Consolidation Method
The idea behind the debt consolidation method is to simplify your debts from a few into one. Ideally, the new consolidated debt will be the lowest cost and will save you more money over the term of the loan. For example, if you have three credit cards with interest rates of 12%, 15%, and 20%, you can try to consolidate your loans into one with a lower interest rate of 4%. Comparing to the debt Avalanche or Snowball, this method is much more efficient.
If you own a home, you can use the equity in your home by refinancing your mortgage to a higher amount at a lower interest rate than your outstanding loans. You use the proceed to pay off the outstanding loans. Alternatively, you can also apply for a home equity line of credit (HELOC) and do the same. However, be warned that this method is only a quick fix to your debt problem. It’s not a long-term solution.
The Balance Transfer Method
The balance transfer method involves applying for a new credit card that allows you to transfer your balance from other cards to the new card. For most cards, it’ll cost you about 1% of the balance that you transfer. You pay a low-interest rate of 0% to 1% for one year (the low-interest period). You don’t need to pay the minimum payment for that period. However, the interest rate skyrockets after the lower interest period are over.
When you choose this method, hopefully, you’ll continue to make your loan payments and take advantage of the low-interest rate. If you can’t pay off the whole loan before the low-interest period expires, you can repeat the process with another card. Be warned that this method has the potential to get out of hand if don’t continue to pay off your debt.
Debt Relieve Method
If you had tried all of the four above methods and you are still unable to make a dent on your debt balance, the last resort may be to contact a debt relief consultant. I had no experience with this method, but from what I had read, it’s an alternative to declaring bankruptcy. If you can’t make your payments and your balance keeps on ballooning, this is probably your last option. Hopefully, no one has to resort to this.
My Two Cents
With all these debt reduction methods to get you out of debt, there is absolutely no guarantee that you’ll be debt-free once you paid off your debt. The best way to get out of debt is not getting into debt in the first place. You’ll never have to find the best way to get out of debt if you had never gotten into it. Hence, live within your means and spend less than your earnings so you’ll never have to be in debt.
So, have you ever been in debt? If yes, which method was the best method that you used to get out of debt? Do you know of another debt elimination method that was not mentioned here?